The White Law Group has represented hundreds of investors in claims involving Regulation D private placement investments sold by independent broker-dealers.
Often these investments are touted for their income potential and for being “non-correlated” to the stock market. Too often the financial advisor or broker ignores and/or fails to disclose the risks involved in these investments. The following is a brief explanation of the basics of securities offerings under Regulation D and the risks and features involved with this type of investment.
In the United States, the Securities Act of 1933 mandates that all securities must be registered with the Securities and Exchange Commission (SEC) or qualify for an exemption.
Private market exemptions including Regulation D, Regulation A, Regulation Crowdfunding, Rule 144A, and other section 4(a)(2) private offerings, however, allow a great deal of capital in private markets to be raised without registering through the SEC in the way that a public company must.
The most common exemption used is Regulation D.
The purpose of Regulation D is to allow small to midsize companies an opportunity to raise capital from investors with less expense and reporting requirements than traditional means.
Both private and public companies engage in private placements to raise capital. Since there are less reporting requirements, private placements are not subject to some of the laws and regulations that are designed to protect investors, such as the comprehensive disclosure requirements that apply to registered offerings.
The Nine Rules of Regulation D
Of the nine rules of Regulation D, six are administrative and three are exemptions (Rule 504, Rule 505, Rule 506).
Rule 500, Use of, describes the basic principles and guidelines as well as who can, and cannot use the exemptions.
Rule 501, Accredited Investors
Rule 501 defines Accredited Investor since most offerings under Regulation D have limitations on who can invest.
To be considered an Accredited Investor who can invest in a regulation D private placement, you must meet one of the following requirements:
- You must have an individual income of $200,000 per year for the past two years with an expectation to meet the same for the current year.
- Or, have a combined income of $300,000 per year with your spouse, for the past two years with an expectation of meeting the same number for the current year.
- Or, have a minimum net worth of $1,000,000, not including the value of your home.
The problem with these standards is that they have not been adjusted for inflation in decades. Initially these income and net worth levels were meant to restrict private placements to only the wealthiest, most sophisticated investors. However, by failing to adjust the numbers for inflation, now private placements, with all their complexities and risks, can be sold to a much larger segment of society. Many of whom are not sophisticated investors as was originally intended.
Rule 502, Requirements
There are four universal requirements under 502 — integration, information requirements, limitation on manner of marketing and limitations on resale.
- Integration- All sales that are part of the same Regulation D offering must meet all of the terms and conditions of Regulation D. Its purpose is to regulate companies to make sure they are not separating a single non-exempt offering into multiple exempt ones.
- Information Requirements/Disclosures- Non-accredited investors must receive information and disclosures pertaining to the financial information of the company and to the risks of the investment.
- Limitation on Manner of Offering- General solicitation or general advertising is not allowed. Under this rule, companies can only offer their investments to those they have an existing relationship with.
- Limitations on Resale- There are restrictions on the resale of restricted securities. Often investors will be required to hold the investment for a year or more.
Many companies use FINRA registered broker-dealers to sell their offerings. These broker-dealers become responsible for ensuring that the offering complies with SEC rules, including how it is marketed and to whom it is sold, and the firms are typically paid 7-10% commission for this service.
Rule 503, Form D requires companies to file a notice with the Securities and Exchange Commission. The notice is called a Form D.
The form D sets out the very basic of the offering – how much money is to be raised, who the principles of the offering are, and who will be hired as selling agent (if any has been retained).
Rule 504 permits certain issuers to offer and sell up to $1 million of securities in any 12-month period. These securities may be sold to any number and type of investor, and the issuer is not subject to specific disclosure requirements. Generally, securities issued under Rule 504 will be restricted securities , unless the offering meets certain additional requirements. As a prospective investor, you should confirm with the issuer whether the securities being offered under this rule will be restricted.
Rule 505 (Effective May 22, 2017 Rule 505 was Rescinded)
Under Rule 505, issuers may offer and sell up to $5 million of their securities in any 12-month period. There are limits on the types of investors who may purchase the securities. The issuer may sell to an unlimited number of accredited investors, but to no more than 35 non-accredited investors. If the issuer sells its securities to non-accredited investors, the issuer must disclose certain information about itself, including its financial statements. If sales are made only to accredited investors, the issuer has discretion as to what to disclose to investors. Any information provided to accredited investors must be provided to non-accredited investors.
An unlimited amount of money may be raised in offerings relying on one of two possible Rule 506 exemptions.
Rule 506(b) requirements include: a general ban on solicitation, a limitation of no more than 35 non-accredited “sophisticated” investors while an unlimited number of accredited investors can participate, and a restricted security.
Rule 506(c) requirements include: only accredited investors, the company must take reasonable steps to confirm the investor’s accredited status, and a restricted security.
This sophistication requirement may be satisfied by having a purchaser representative for the investor who satisfies the criteria. An investor engaging a purchaser representative should pay particular attention to any conflicts of interest the representative may have.
If non-accredited investors are involved, the issuer must disclose certain information about itself, including its financial statements. If selling only to accredited investors, the issuer has discretion as to what to disclose to investors. Any information provided to accredited investors must be provided to non-accredited investors.
Issuers relying on 506(b) exemptions from registration must provide non-accredited investors an opportunity to ask questions and receive answers regarding the investment.
The Risks of Investing in Reg D Private Placement Offerings
Investments in private placement offerings typically have a higher level of risk than exchange-traded securities due to a number of factors:
- The age of the company,
- The company’s financial history
- the industry in which the company operates
- the experience of the company’s management,
- limited or nonexistent liquidity,
- restrictions on resale of the investment
- Private placements can carry significant risk, and you may lose all of your investment.
- Since they are not traded on any exchange, Private placement offerings are typically illiquid investments. There are often legal or contractual restrictions on your ability to transfer your holdings, and even if sale of your holdings is permitted there may be no buyers. You may need to hold these securities for an indefinite period of time.
- Companies that issue unlisted securities may provide little or no transparency into their ongoing operations and financial condition.
- Some investments may make periodic distributions, but some may not make any.
Free Consultation with a Securities Attorneys
This information is being provided by The White Law Group. The White Law Group, LLC is a national securities fraud, securities arbitration, and investor protection law firm with offices in Chicago, Illinois and Franklin, Tennessee.
If you have suffered significant losses and want to learn more about your legal options against the broker-dealer that sold you a Regulation D private placement investment, please contact the securities attorneys of The White Law Group at 888-637-5510 for a free consultation.
For more information on The White Law Group, visit https://www.whitesecuritieslaw.com.